Customer Logins

Obtain the data you need to make the most informed decisions by accessing our extensive portfolio of information, analytics, and expertise. Sign in to the product or service center of your choice.

Customer Logins

My Logins

All Customer Logins
S&P Global Market Intelligence

  • S&P Global
  • S&P Dow Jones Indices
  • S&P Global Market Intelligence
  • S&P Global Mobility
  • S&P Global Commodity Insights
  • S&P Global Ratings
  • S&P Global Sustainable1
Close
Discover more about S&P Global’s offerings
Investor Relations
  • Investor Relations Overview
  • Investor Presentations
  • Investor Fact Book
  • News Releases
  • Quarterly Earnings
  • SEC Filings & Reports
  • Executive Committee
  • Corporate Governance
  • Merger Information
  • Stock & Dividends
  • Shareholder Services
  • Contact Investor Relations
Languages
  • English
  • 中文
  • 日本語
  • 한국어
  • Português
  • Español
  • ไทย
About
  • About Us
  • Contact Us
  • Email Subscription Center
  • Media Center
  • Glossary
Product Login
S&P Global Market Intelligence
  • Who We Serve
  • Solutions
  • News & Insights
  • Events
  • Product Login
  • Request Follow Up
  •  
    • Academia
    • Commercial Banking
    • Corporations
     
    • Government & Regulatory Agencies
    • Insurance
    • Investment & Global Banking
     
    • Investment Management
    • Private Equity
    • Professional Services
  • WORKFLOW SOLUTIONS
    • Capital Formation
    • Credit and Risk Solutions
    • Data & Distribution
    • Economics & Country Risk
    • Sustainability
    • Financial Technology Solutions
     
    • Issuer & IR Solutions
    • Leveraged Loans
    • Post Trade Processing
    • Private Markets
    • Risk, Compliance, & Reporting
    • Supply Chain
    PRODUCTS
    • S&P Capital IQ Pro
    • S&P Global Marketplace
    • China Credit Analytics
    • Climate Credit Analytics
    • Credit Analytics
    • RatingsDirect ®
    • RatingsXpress ®
    • 451 Research
    See More S&P Global Solutions
     
    • Capital Access
    • Corporate Actions
    • KY3P ®
    • EDM
    • PMI™
    • BD Corporate
    • Bond Pricing
    • ChartIQ
  • CONTENT
    • Latest Headlines
    • Special Features
    • Blog
    • Research
    • Videos
    • Infographics
    • Newsletters
    • Client Case Studies
    PODCASTS
    • Economics & Country Risk
    • IR in Focus
    • Maritime and Trade Talk
    • Masters of Risk
    • Next in Tech
    • Private Markets 360°
    • Street Talk
    • The Pipeline: M&A and IPO Insights
    SEE ALL EPISODES
    SECTOR-SPECIFIC INSIGHTS
    • Differentiated Data
    • Banking & Insurance
    • Energy
    • Maritime, Trade, & Supply Chain
    • Metals & Mining
    • Technology, Media, & Telecoms
    • Investment Research
    • Sector Coverage
    • Expert Directory
    More ways we can help
    NEWS & RESEARCH TOPICS
    • Credit & Risk
    • Cryptocurrency
    • Economics & Country Risk
    • Financial Services
    • Liquidity Crunch
    • Maritime & Trade
    • M&A
    • Sustainability & Climate
    • Technology
    See More
    • All Events
    • Webinars
    • Webinar Replays
    Featured Events
    In PersonCorporate Actions & Securities Processing 2023 EMEA User Group Forum
    • 06/14/2023
    • Druids Glen Hotel & Golf Resort
    • 8:00 am - 5:00 pm
    WebinarDemystifying Climate Risk Reporting for US Commercial Banks
    • 06/14/2023
    • Live, Online
    • 11:00 am - 12:00 pm EDT
    WebinarEmbracing Embedded Finance: How Banks and Insurers are Finding New Ways to Reach Customers
    • 06/13/2023
    • Live, Online
    • 11:00 am - 12:00 pm EDT
  • PLATFORMS
    • S&P Capital IQ Pro
    • S&P Capital IQ
    • S&P Global China Credit Analytics
    OTHER PRODUCTS
    • Credit Analytics
    • Panjiva
    • Money Market Directories
     
    • Research Online
    • 451 Research
    See All Product Logins
BLOG Feb 26, 2018

CVA Wrong Way Risk: What does the CDS data tell us?

Contributor Image
Bill Chung

The wrong way risk (WWR) modelling of valuation adjustments (xVAs) is known to be a challenging problem, if not intractable. This is due to the lack of relevant historical data and potential for misspecification in the joint modelling of discrete default event and continuous risk factor movement (Aziz et. al, 2014). In this article, we revisit WWR modelling by using information from the credit default swap (CDS) market. In particular, we analyze the market prices of Quanto CDS contracts, which are designed to provide credit protection against the default of a reference entity and are settled in a non-domestic currency. The contingent payoff of the Quanto CDS contract naturally reflects the market-implied interaction of FX risk and credit default event, and hence, sheds light on the level of WWR for FX-sensitive trades and portfolios.

Figure 1 shows the Japan sovereign CDS premium (5-year par spread) which represents the cost of buying credit protection for a Japan sovereign default. The USD spread and JPY spread correspond to the CDS contracts in which the settlement currencies are in USD and JPY, respectively. One can find an intriguing persistent basis between the two CDS spreads, despite the fact that they are referencing the same entity. Indeed, the persistent Quanto basis reflects a strong devaluation jump of the JPY against USD upon a Japan sovereign default – and those who bought the CDS contract settled in USD will have to pay a higher premium in order to shield themselves from the FX devaluation risk. This illustrates that the CDS market has been pricing in WWR consistently, that is, the FX-credit interaction as a devaluation jump upon a counterparty default.


Figure 1: Japan sovereign CDS spreads denominated in USD and JPY

According to the no-arbitrage argument, one can long a CDS contract in JPY and short a Quanto CDS contract in USD, and since the underlying credit events are identical, what is left behind in the portfolio is the FX risk of the dollar-yen exchange rates at default. This insight leads to the rule-of-thumb:

where γ is the jump size of the FX risk factor at the counterparty default, SJPY and SUSD are the CDS spreads denominated in JPY and USD respectively. The estimated FX jump size can be readily used as the input parameters for the FX jump-at-default xVA WWR model implemented within the IHS Markit xVA solution.

In Figure 2, we plot the historical mean and standard deviation of the implied FX jump size for different counterparties. A number of interesting implications can be drawn. Firstly, all of the implied FX jump sizes are significantly negative (i.e., JPY devaluation), suggesting that the CDS market has been consistently pricing in WWR between FX rate and credit default for these systemically large counterparties. Secondly, the implied FX jump size is strongly related to the systemic importance of the reference entity and we observe a decreasing impact of FX rate down the spectrum, confirming the anecdotal evidence that the Quanto CDS implied jump size is related to systemic importance (Pykhtin and Sokol, 2013). The similar level of FX jump sizes across industry groups also points to the possibility of building a “sector basis curve”, hence allowing one to estimate the FX-WWR for a wider range of counterparties. For a more detailed analysis, we will shortly be publishing a technical white paper on the calibration of WWR models to the Quanto basis.

Figure 2: Implied FX jump sizes across different Japanese names

The FRTB-CVA regulation requires banks to apply WWR modelling when the dependence between exposure and counterparty credit quality is significant. To make this judgment, one can be complemented by market-implied information from the Quanto CDS data – a significant Quanto basis indicates the counterparty is exposed to FX-WWR which requires monitoring and active management. Our analysis shows that for these counterparties the CVA WWR add-on could be 50% higher against the no-WWR baseline, and therefore choosing a proper jump-at-default WWR model is critical to capture the impact.

Interested in learning more? Please visit Financial Risk Analytics.

References

  1. Aziz, A., Boetcher, B., Gregory, J. and Kreinin, A. (2014) Best Market Practice for Calculation and Reporting of Wrong-Way Risk. IBM Software, Business Analytics.
  2. Pykhtin, M. and Sokol, A. (2013) Exposure under Systemic Impact. Risk 26(9), 100-105.

Bill Chung is senior quantitative analyst, Financial Risk Analytics at IHS Markit

Previous Next
Recommended for you

Purchasing Managers Index (PMI)

Investment Manager Index (IMI) Survey

Unlock comprehensive monthly insights into investor sentiment
Sign up participate
Related Posts
VIEW ALL
Economics Commentary Jun 09, 2023

Monthly PMI Bulletin: June 2023

Economics Commentary Jun 09, 2023

Week Ahead Economic Preview: Week of 12 June 2023

Economics Commentary Jun 07, 2023

Financial services lead global growth higher in May, stoking inflation

VIEW ALL

Follow Us

Jun 09
SPGlobalPMI@SPGlobalPMI

📅Central bank meetings are in focus next week incl. #US, #eurozone and #Japan updates, plus further insights into e… https://t.co/TSvNzS8qwF

Jun 09
Jun 09
SPGlobalPMI@SPGlobalPMI

RT @Judo_Bank: Judo Bank, in partnership with @SPGlobal, is pleased to announce the launch of the Judo Bank SME Business Activity Report. T…

Jun 09
Jun 08
SPGlobalPMI@SPGlobalPMI

#India led the upturn in emerging markets with growth staying near a 13-year high, while in developed markets #US a… https://t.co/8c4BufUKpX

Jun 08
Jun 07
SPGlobalPMI@SPGlobalPMI

Global growth hit its highest level in one-and-a-half years in May, helped by a record expansion in foreign new bus… https://t.co/1xODuCaSxz

Jun 07
{"items" : [ {"name":"share","enabled":true,"desc":"<strong>Share</strong>","mobdesc":"Share","options":[ {"name":"facebook","url":"https://www.facebook.com/sharer.php?u=http%3a%2f%2fwww.spglobal.com%2fmarketintelligence%2fen%2fmi%2fresearch-analysis%2fCVA-wrong-way-risk.html","enabled":true},{"name":"twitter","url":"https://twitter.com/intent/tweet?url=http%3a%2f%2fwww.spglobal.com%2fmarketintelligence%2fen%2fmi%2fresearch-analysis%2fCVA-wrong-way-risk.html&text=CVA+Wrong+Way+Risk%3a+What+does+the+CDS+data+tell+us%3f","enabled":true},{"name":"linkedin","url":"https://www.linkedin.com/sharing/share-offsite/?url=http%3a%2f%2fwww.spglobal.com%2fmarketintelligence%2fen%2fmi%2fresearch-analysis%2fCVA-wrong-way-risk.html","enabled":true},{"name":"email","url":"?subject=CVA Wrong Way Risk: What does the CDS data tell us?&body=http%3a%2f%2fwww.spglobal.com%2fmarketintelligence%2fen%2fmi%2fresearch-analysis%2fCVA-wrong-way-risk.html","enabled":true},{"name":"whatsapp","url":"https://api.whatsapp.com/send?text=CVA+Wrong+Way+Risk%3a+What+does+the+CDS+data+tell+us%3f http%3a%2f%2fwww.spglobal.com%2fmarketintelligence%2fen%2fmi%2fresearch-analysis%2fCVA-wrong-way-risk.html","enabled":true}]}, {"name":"rtt","enabled":true,"mobdesc":"Top"} ]}
Filter Sort
  • About Us
  • Quality Program
  • Contact Us
  • Email Subscription Center
  • Press Releases
  • Careers
  • Corporate Responsibility
  • Our History
  • Investor Relations
  • Leadership
  • © 2023 S&P Global
  • Terms of Use
  • Cookie Notice
  • Privacy Policy
  • Disclosures
  • Do Not Sell My Personal Information